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Should You Like China Tian Lun Gas Holdings Limited’s (HKG:1600) High Return On Capital Employed?

Simply Wall St

Today we'll look at China Tian Lun Gas Holdings Limited (HKG:1600) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

How Do You Calculate Return On Capital Employed?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for China Tian Lun Gas Holdings:

0.15 = CN¥1.2b ÷ (CN¥11b - CN¥3.5b) (Based on the trailing twelve months to December 2018.)

So, China Tian Lun Gas Holdings has an ROCE of 15%.

Check out our latest analysis for China Tian Lun Gas Holdings

Does China Tian Lun Gas Holdings Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that China Tian Lun Gas Holdings's ROCE is meaningfully better than the 9.4% average in the Gas Utilities industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where China Tian Lun Gas Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that China Tian Lun Gas Holdings currently has an ROCE of 15%, compared to its ROCE of 9.4% 3 years ago. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how China Tian Lun Gas Holdings's past growth compares to other companies.

SEHK:1600 Past Revenue and Net Income, July 31st 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Tian Lun Gas Holdings.

China Tian Lun Gas Holdings's Current Liabilities And Their Impact On Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

China Tian Lun Gas Holdings has total liabilities of CN¥3.5b and total assets of CN¥11b. As a result, its current liabilities are equal to approximately 30% of its total assets. With this level of current liabilities, China Tian Lun Gas Holdings's ROCE is boosted somewhat.

The Bottom Line On China Tian Lun Gas Holdings's ROCE

While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. China Tian Lun Gas Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

I will like China Tian Lun Gas Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.